In today’s volatile real estate market, it can be difficult to gauge where current home values stand in relation to their historic norms. The price-to-income ratio is a useful metric when gauging this, and when comparing the affordability of housing across different cities in the United States. The ratio compares the median price of a house to the median level of household income in a given area. Specifically, we used the metro-level Zillow Home Value Index, which is a measure of home values for a given metro, as well as median household income for that metro. Median household income is only available through 2009. After that year we calculated the median household income by estimating it via Bureau of Labor Statistics wage growth rates. In this research brief we consider 130 metros and the United States as a whole.
Compared to their historical averages, measured from the first quarter of 1985 to the fourth quarter of 1999, 42 metros are below their historical average, while 85 metros and the United States as a whole are above their historical average. Three of the metros are exactly at their historical mean. The United States currently has a price-to-income ratio that is equal to 3.3, which puts it at 14 percent over its historical average. Sixty-two metros are still more than 10 percent over their historic average. Fourteen metros have overshot their historical average by more than 10%.
In terms of over-correction, Manchester, NH (-19%), Las Vegas (-25%) and Detroit (-35%) are extreme outliers. We don’t necessarily expect these to return to historical levels as there may have been a regime shift in these housing markets meaning that price-to-income ratios may not return to historical levels because of fundamental changes in local housing demand. This holds especially true for Detroit. Manchester has experienced noticeable regime shifts in the past and it is now close to the price-to-income ratio low point in 1998.
On the other end of the price-to-income spectrum, there are many more markets that are still very high compared to their historical averages. Fifteen metros are 15% to 49% over their historic averages, with Knoxville (40%), Eugene (40%), Richmond (42%), Boulder (43%), Charleston (46%), Honolulu (47%), and Virginia Beach (49%) all 40% above their historical price-to-income levels. Both Boulder and Eugene already showed signs of a higher price-to-income ratio early in the 1990s.
Interpreting price-to-income ratios is part art and part science. The price-to-income ratio is useful in visualizing the historical anomaly of the real estate bubble that occurred in many markets between 2000 and 2006. Generally, for markets which have had some stability in price-to-income ratios, deviations from long-term trends tend to be followed by a return to historical levels. This has clearly occurred in all markets that experienced a pronounced housing bubble. As we’ve seen, this correction can also go too far for a variety of reasons, leaving price-to-income levels below historical norms. In this case, it does suggest that home values in such markets represent a compelling value relative to the amount of income that residents have typically spent on housing. This, in turn, might suggest that demand for housing in these markets will increase as buyers take advantage of this value proposition, thus producing a stabilization in home values near-term and, longer term, the potential for price appreciation.
Conversely, markets in which the price-to-income level is still substantially above historical levels may see further declines in home values before stabilizing. Or, instead of home values falling in order to reach equilibrium with income levels, home values in these markets may stabilize sooner but stay flat for a longer period of time until future income growth brings the price-to-income ratio back into alignment with historical levels.
